Annual Threshold Is Now $25 Million; More Can Use Completed Contract Accounting Method
It will be some time before absolutely everything in the Tax Cuts and Jobs Act, signed into law by President Trump last December, gets unpacked and understood. But as a construction contractor, you may be quite interested in one of the law’s lesser-known provisions: the redefinition of “small construction contractors,” and how it affects your choice of tax accounting methods.
The Percentage of Completion Method (PCM), which recognizes income and expenses as work is performed, must be used by many contractors, especially large ones. The downside of this option? Complex, time-consuming look-back calculations.
Before the Tax Cuts and Jobs Act was passed, a small construction contractor was defined as one who had averaged gross receipts of $10 million or less during the past three years, and whose contracts were written for less than two years. These companies had more options when it came to choosing an accounting method. In addition to the PCM, they could use:
- The Cash Method, wherein your accounting system recognizes income as it’s collected and expenses as they’re paid. Since it allows for income deferral, it would be especially advantageous tax-wise if you bill clients later in the project (or after you’ve incurred significant expenses). Conversely, if you frontload billings before you’ve spent a lot of money on the job, the Cash Method would not be optimal.
- The Completed Contract Method, which recognizes income and expenses at each job’s completion. This deferral of both may make this a good option for jobs that will be finished shortly after the end of the year.
New Threshold, More Flexibility
Thanks to the Tax Cuts and Jobs Act, the IRS now considers “small construction contractors” to be those whose gross receipts are under $25 million, rather than the previous $10 million. They’re now allowed to use the Completed Contract Method for contracts that are expected to be completed within two years and/or the Cash Method.
How do you determine the best method for your business? You’ll need to start by answering three questions:
- How big is your company?
- What is the length of your contracts? This, of course, will vary according to job.
- What types of contracts do you write? Again, this is variable.
Your choice of tax accounting methods is extremely important, since the right one may result in significant tax savings or the deferral of taxes. We understand the differences quite well, and can help steer you in the right direction. So connect with us as soon as possible.